Wednesday, June 26, 2013

Ellis, Winning the Loser’s Game, 6th ed.

Those who are convinced they can consistently beat the market will find Charles D. Ellis’s book depressing reading. The underlying thesis of Winning the Loser’s Game: Timeless Strategies for Successful Investing, 6th ed. (McGraw-Hill, 2013) is that in recent decades investment management has evolved from a winner’s game to a loser’s game because “the market came to be dominated by the very institutions that were striving to win by outperforming the market. No longer is the active investment manager competing with overly cautious custodians or overly confident amateurs who are out of touch with the fast-moving market. Now he or she competes with other hardworking investment experts in a loser’s game where the secret to ‘winning’ is to lose less than the others lose.” (pp. 5-6)

Put another way, and here I invoke Michael Mauboussin’s The Success Equation, we are faced with the paradox of skill: “As skill improves, performance becomes more consistent, and therefore luck becomes more important.” That is, as the population of skilled investors rises, with individual retail investors moving to the sidelines, the variation in skill narrows and luck plays a greater role in outperformance. And, as we all know, luck is not predictable. That an investor manager has outperformed the market in the past two or three—or even fifteen—years in no way guarantees that his luck will continue. Bill Miller of Legg Mason is, of course, the poster child for this truism.

However you slice it, Ellis argues that the individual investor must reconcile himself to the fact that he will not get outsized returns year after year, whether he hands his money over to a fund manager or (normally even worse) pursues the do-it-yourself route. Instead, he must plod along, trying to minimize mistakes. Ellis puts it in less tortoise-like language: “As all grandparents and most parents know—and as most grandchildren will come to know—the real test of a good driver is simple: no serious accidents. And as all flyers know, safe, dull—even boring—is the essence of a good flight. The secret to success in investing is not in beating the market any more than success in driving is going 10 MPH over the posted speed limit. Success in driving is being on the right road and moving at a reasonable speed.” (p. 51)

What are some of the mistakes investors make? They pay too much in fees, they trade too often, they ignore tax considerations, they fail to diversify, and they have no clearly defined objectives.

And if you still think that active management is the way to go, Ellis offers a couple of sobering statistics: “Over 10-year periods, two out of three active managers’ results fall below the market averages—and below index funds. Over longer periods, more fall below.” And “Those managers who fall short fall short by nearly twice as much as those who do better do better.” (p. 153) He adds, “Yes, Virginia, some managers will always beat the market, but we have no reliable way of determining in advance which specific managers will be the lucky ones.” (p. 166)

There are more than 500,000 copies of Winning the Loser’s Game in print. Whether readers acted on Ellis’s advice or promptly ignored what they were told I have no way of knowing. Creators of mutual funds and ETFs certainly listened. There is now a virtual supermarket of index and quasi-index funds and ETFs available. Some have higher fees than others, some trade more frequently than others, some (beware!) are pegged to bizarre indexes. All in all, the investor still has his work cut out for him. Ellis is standing by to lend him a helping hand.

1 comment:

  1. What is an investor looking for when funds are deployed? To compound those funds over a period of time to save purchasing power as well as earn a decent returns.
    Since it's not a straight line from point A to B ( even in fixed income as rate of interest changes ) with tolerable variations ( investor tolerance differs).Expecting a fund manager who has to hold cash for redemption's ( open end funds), has to pay for transactions and earn a living will always under perform an index which has no transaction costs, or salaries to be paid.

    As Mr. Ellis points out 2 out of 3 managers have under performed benchmarks over 10 years means 33% have performed better in terms of returns, bu what about variation does the other 2 managers have more or less variation than the benchmark or the index. If they had under performed the benchmark/index slightly but with much less variation in returns than the benchmark/Index they are adding value.

    If there are 100 students who took an exam and 60 is the average score, there will always be some students who are below average and some above averages because many are below average does not mean that not every one can be above average. There are always some whoc can be above average.

    In investment management we are always benchmarking managers to indexes and comparing them on a very short term periods of quarters and years, but as indicated by many hedge fund managers from 1980's there are many manager who've done better than indices and benchmarks either with higher risk/higher returns or lower risk/lower returns. Many have underperformed the indexes for substantial periods ( ex seth klarman during 1990's) but still had provided higher returns than the benchmark over the long term.

    If luck is more important than skill as skill increases why does major sport franchises look for skill which leaves the result from something they can identify and use to something they have no control over.Good Investment managers agree that luck does play a role in the short term but skill wins out over the long run. The same applies to high skilled activities like sports where luck does determine results in a match, but over the season and long term team with better skills required for the sport will do well.

    I do think one indisputable fact is that there are many investors who does not have the time nor the understanding to identify the managers & strategies that have better chance of performing well over time. ETF's and Index funds are most suitable for such investors.